Can High Gas Prices Lift Coal's Spirits?

Don't look now, but domestic coal is ready for an uptick. At least that's what Joy Global (NYSE: JOY) seemed to be saying during its second-quarter conference call. That may sound ridiculous based on the recently proposed carbon dioxide rules, but the truth is U.S. thermal coal is actually in a good spot right now. Take a look at diversified coal miner Rhino Resource Partners (NYSE: RNO) to take advantage of the uptick.

What this supplier is seeingJoy Global sells mining equipment, and the global coal industry is a big end market. U.S. thermal coal was one of the first coal regions to head south, but if Joy Global's CEO Ted Doheny is right, it's getting set to break out of that funk. And the big change is natural gas:

[W]e've talked a while about what's happening with natural gas. With natural gas coming a little bit below $5, it puts various basins in play.

(Source: Joy Global, via Wikimedia Commons)

In the Powder River Basin (PRB), which is one of the lowest cost coal regions in the country, Joy Global is seeing "fairly strong activity on the service side." There's also been more activity in the Illinois Basin (ILB), which is another relatively cheap coal region. In fact, Joy Global increased its "longwall presence" in the ILB, according to Doheny.

These two regions are competitive, with natural gas priced much lower than it is today. The southern region of the PRB, for example, can compete with gas priced as low as $2.50. The ILB, meanwhile, can compete with natural gas in the $3.50 to $3.75 range. Look for these two regions to do relatively well as utilities shift toward the lowest-cost fuel options.

However, the good news doesn't end there. Joy Global's Doheny noted, "[W]e've seen activity in Northern App and we feel pretty good about that, and that's also showing up on service business." Northern Appalachia (NAPP) is more expensive to mine than the PRB or ILB, but it starts to get competitive when gas is in the $4.50 range. So even NAPP coal could see solid demand.

You can't play them allThere's no miner that is perfectly positioned in each of these favorable markets. However, small but broadly diversified Rhino Resource Partners is a solid option. For starters, this limited partnership sports a yield of more than 13%. So you are getting paid very well today for taking on the headline risks in the coal market.

And while those risks, including changing environmental regulations, are quite real, Rhino has an interesting balance sheet. There's virtually no debt. Last year it sold a collection of natural gas assets and used the proceeds to essentially eliminate any threat of being over-leveraged. This should allow the miner to coast through this downturn while others are struggling to survive.

(Source: ReubenGBrewer, via Wikimedia Commons)

The big news, however, is that Rhino Resource Partners is opening a new mine in the Illinois Basin that could materially alter its long-term prospects. And most of the costs of opening that mine have already been paid. The mine already has a customer for 800,000 tons a year but has the potential to produce as much as 2 million tons.

In addition to 144 million tons of ILB reserves, Rhino has another 80 million tons of reserves in NAPP. And while its Western operations aren't in the PRB, Rhino Resource Partners was able to sell its Western coal for $40 per ton in 2013, about $7 per ton more than its mining costs there. These three regions together account for roughly 55% of the partnership's reserves.

Calling the upturnSo it looks like Joy Global is actually calling an upturn in U.S. thermal coal. Although there's no investment option that hits all the right coal basins, high-yielding Rhino Resource Partners is in two. And its ILB exposure could turn into a major bright spot as the new mine comes online. It's important to keep an eye on changing environmental regulations, but don't let the news fool you into believing that coal is dead -- it isn't.

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